The Dynamic Efficiency Cost of Not Taxing Housing

Abstract

Housing assets comprise nearly one-third of household wealth rot effectively escape income taxation. When housing is included in the life cycle model, the capital income tax is shown to be far more distortionary than previously thought. The reason is that capital income taxation stimulates the price of (untaxed) housing capital and thereby crowds out nonhousing wealth in the long-run. Even when aggregate saving is unaffected by the after-tax rate of return, the crowding out of nonhousing wealth erodes the tax base end generates very high measures of marginal excess burden. Movements in U.S. aggregate wealth are consistent with the predictions of the model. Overall household wealth as a ratio of national income in 1989 is nearly identical to the ratio in 1955, but the ratio of housing assets to nonhousing wealth has grown by 30 percent since 1970. In short, capital income taxation may attenuate capital accumulation through its impact on housing prices rather than through traditional incentive effects.